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Only Housing Follows the Slowdown Script

Real estate has cooled, but the rest of the economy is red hot, complicating the FOMC's efforts.

The devil wears Prada, and shops incessantly at


(JWN) - Get Report

despite the price of gasoline, and hasn't stopped spending even in the worst of times this decade. It seems a bit ambitious to count on the housing market to do the whole job of slowing the economy, especially via the consumer.

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A soft landing for the housing explosion is an ideal scenario for the

Federal Reserve

, which this week is widely expected to deliver its 16th consecutive rate hike since June 2004, and pause thereafter. The Fed wants to put the brakes on the economy, and most evidence points to a downshift in housing but a full-throttle economy everywhere else.

Capital markets are displaying massive risk tolerance, companies have more cash than they know how to use, and consumers keep spending. In other words, the Fed's job is more complicated than just slowing the housing market.

In the slowdown category, homebuilder

Toll Brothers

(TOL) - Get Report

said last week its orders were down 29% in its fiscal second quarter and its outlook going forward wasn't much better. Also,

Hovnanian Enterprises

(HOV) - Get Report

said that higher cancellation rates, slower sales and production delays led it to cut its earnings outlook for the rest of the year.



did the same the week prior.

On Monday, when major averages were relatively flat, JPMorgan cut its rating of Centex to underweight from neutral, and on

Ryland Group


to neutral from overweight. Centex fell 2.19% to $55.70 per share and Ryland was down 2.61% to $62.64.

On the lending side,


said last week it will slash 3,800 jobs and close branches as the housing market slows. Reports of small, regional mortgage lenders cutting jobs also have increased, noted John Lonski, chief economist at Moody's Investors Service.

On the other hand,


(WB) - Get Report

sure found

Golden West Financial's


$122 billion mortgage portfolio attractive. It announced plans Sunday to buy Golden West for $25 billion in cash and stock. While some analysts say the mortgage portfolio, almost 99% composed of adjustable-rate mortgages, is risky, it is nonetheless a cash cow. The mortgages reset to higher rates with a lag to the Fed tightening, making Wachovia's purchase "good timing," says David Hendler, analyst at CreditSights.

Wachovia's shares ended 6.68% lower Monday to close at $55.42, while Golden West's rose 6.23% to $74.90.

Broadly speaking, the Wachovia-Golden West deal and other M&A activity are signaling burgeoning business confidence, which is complicating the Fed's efforts. In other deal-making Monday,

Fisher Scientific


agreed to acquire

Thermo Electron

(TMO) - Get Report

while Canadian zinc giant

Teck Cominco

announced a $16 billion hostile bid for




As for the housing market, the timing of the Wachovia-Golden West deal challenges conventional thinking that residential activity has peaked, or worse.

The Bouncing Beach Ball

Housing prices skyrocketed since the early 2000s as low interest rates and loose mortgage-lending standards were facilitated by institutional investors seeking securitizations of just about any and all types of loans. That left consumers owning homes, a valuable asset, but with their necks on the line if rates were to rise quickly or prices fall quickly.

Mortgage lenders developed products that allowed lower-quality lenders to buy costly homes by paying adjustable-rate loans, or interest-only and no principal, or to choose each year among several payment options depending on one's financial status (these are called Option ARMs). Such subprime mortgage origination has increased 35% in the five years ended 2005. That is double the growth rate of overall mortgage origination, which increased by 19% over the same period, according to Moody's.

The party hasn't stopped even though the hangover may be looming. For the first two months of 2006, Moody's rated $96 billion worth of mortgage-backed securities in the first two months of this year, up 85% from the $52 billion rated in the first two months of 2005. The market for mortgage-backed securities has exploded this decade, from $61 billion rated by Moody's in 2000 to $548 billion in 2005.

Banking regulators have taken notice of the loose lending standards and floated a proposal for new rules on nontraditional lending. The comment period on the proposal ended recently, and no rules have been adopted, says Hendler. But "we think the goal of the regulators is clearly to slow the riskiest lending and introduce greater scrutiny into the mortgage sector."

The decline is under way, says W. Scott Simon, managing director and senior member of Pimco's Portfolio Management and Strategy Groups. "The volume of sales is down at least 10%, the number of homes on the market is starting to really skyrocket, the number of days homes are on the market is increasing, affordability has gotten much worse, and interest rates are up." (

What could be better?


While some data support Simon's theory, other reports defy the negativity.

Last week, the National Association of Realtors reported that pending home sales declined by 1.2%, much higher than the 0.5% expected drop. March data showed increases in new- and existing-home sales, but the news was also tempered by a decline in median home prices, rising inventories and declines in mortgage applications. In an odd turn, mortgage applications were slightly higher last week, even as the average 30-year mortgage rate as of the week ended May 4 was 6.59%, up from 6.21% in the week ended Jan. 5, according to Freddie Mac.

"The run-up in gold, copper and oil has allowed everyone to take their eyes off the one beachball that is in the process of disinflating if not deflating: housing," says David Rosenberg, North American economist at Merrill Lynch.

The Fed has its eye on this ball, however. San Francisco Fed President Janet Yellen said in a speech last month that a slowdown in the housing market would dampen consumer spending and therefore reinforce the Fed's rate-hiking campaign thus far. The FOMC is expected to raise its fed funds rate to 5% this week, at its meeting ending Wednesday.

Fed Chairman Ben Bernanke in his testimony to the Joint Economic Committee earlier this month reiterated Yellen's point when he said: "Significant uncertainty attends the outlook for housing, and the risk exists that a slowdown more pronounced than we currently expect could prove a drag on growth this year and next."

A slowdown in housing could create financial restraint in the consumer marketplace, where, unlike corporations, the savings rate is nil. The trick is to avoid damaging the consumer too much. Labor is key to the equation, says Lonski. If Americans still have jobs, they can service their debt, and keep spending. (Friday's disappointing payroll data aside, the 4.7% unemployment rate is at a level most economists associate with full employment.)

Consumers are mired in debt. The Federal Reserve reports that U.S. consumer credit for March reached a record $2.161 trillion. Consumer revolving credit reached $805.6 billion in March. Payment of debt as a percentage of household disposable income is almost 14%, on a climbing trend from near 10.5% in 1994, according to Citigroup.

Most observers agree the low-rate petri dish of the past few years led to unrivaled speculative fervor in housing. But expectations by central bankers and others that the materialistic American consumer will drag down the overall economy due to depreciation in the value of their homes seems a difficult line to tow.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click


to send her an email.